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Don't be blinded by the juicy distribution yields of 6% to 10% offered by some closed-end funds. At best, these funds harbor risks that investors ought to know about and understand. And, at worst, the high yields are luring buyers at the wrong moment, when the funds are in danger of falling sharply in value.

The shares of many high-yielding closed-ends now trade far above net asset value, or what their underlying assets are worth. Some are priced "just" 20% to 30% above NAV, while one fund,
Pimco High IncomePHK -0.1088139281828074%PIMCO High Income FundU.S.: NYSE9.18
-0.01-0.1088139281828074%
/Date(1481307620680-0600)/
Volume (Delayed 15m)
:
218876
P/E Ratio
N/AMarket Cap
N/A
Dividend Yield
13.512407488027863% Rev. per Employee
N/AMore quote details and news »PHKinYour ValueYour ChangeShort position
Fund (ticker: PHK), trades at a 70% premium to NAV. These funds are an expensive bet on vehicles that historically have sold near net asset value. The current distortion relates to the hunger for yield at a time when 10-year Treasuries yield a pathetic 1.7%.

Many closed-ends use leverage and take other credit risks to generate such hefty distributions. If interest rates rise, however, or the economy falters, the funds' investments could shrivel in value.

Sixty-six percent of taxable bond funds and 73% of municipal-bond funds trade above NAV now, versus roughly 30% both a year ago and in 2006, before the financial crisis, according to Thomas J. Herzfeld Advisors, a closed-end specialist based in Miami Beach. "A lot of new investors are looking at closed-end funds," says Cecilia Gondor, Herzfeld's chief investment officer. "They are looking for yield and aren't necessarily focused on premium."

Not surprisingly, funds with some of the highest distribution yields also have the highest premiums. Using CEFConnect.com, a closed-end-fund tracking service, Barron's recently screened for funds with the highest premiums to NAV and assets north of $100 million.
Pimco Global StocksPLUS & IncomePGP -0.7667731629392971%PIMCO Global StocksPLUS & Income FundU.S.: NYSE15.53
-0.12-0.7667731629392971%
/Date(1481306270001-0600)/
Volume (Delayed 15m)
:
35773
P/E Ratio
N/AMarket Cap
N/A
Dividend Yield
11.333934320669671% Rev. per Employee
N/AMore quote details and news »PGPinYour ValueYour ChangeShort position
Fund (PGP) ranked No. 2, with assets of $13 per share and a 9.9% yield. It fetches a 68% premium, much as it did in January when our colleague Randy Forsyth at Barrons.com cast a wary eye on the fund ("The Pimco Premium -- Totally Gross?" Jan. 23).

"Closed-end funds trade primarily based upon yield and the reliability of that yield," Bill Gross, Pimco's founder and co-chief investment officer, e-mailed in response to a Barron's query for this article. "If a fund trades consistently above NAV, it is usually a reflection of investors' perception that the yield these assets generate will be maintained." Five Pimco funds ranked among the top 10 in our screen. The firm declined to comment further.

Many of the funds on our list didn't boast such wide premiums until two years ago, when equity-market losses scared investors, interest rates plummeted, and demand for income increased. From 2002 through 2006,
Pioneer High Income TrustPHT 0.6060606060606061%Pioneer High Income TrustU.S.: NYSE9.96
0.060.6060606060606061%
/Date(1481306625170-0600)/
Volume (Delayed 15m)
:
37487
P/E Ratio
N/AMarket Cap
N/A
Dividend Yield
10.240963855421686% Rev. per Employee
N/AMore quote details and news »PHTinYour ValueYour ChangeShort position
(PHT), for instance, traded close to NAV. Its premium has grown sharply since 2010, to today's 37%.

THERE ARE MANY REASONS INVESTOR sentiment could shift, sending shares tumbling. Any hint of rising interest rates would be a concern, as would expectations that the gap between short- and long-term rates might narrow. That would hurt funds relying on short-term borrowing to buy long-term assets.

Premiums also could fall if a fund cuts its payout or sells new shares, Gondor says. The
Gabelli Utility TrustGUT 0.25020177562550444%Gabelli Utility TrustU.S.: NYSE6.2105
0.01550.25020177562550444%
/Date(1481307202813-0600)/
Volume (Delayed 15m)
:
37513
P/E Ratio
N/AMarket Cap
N/A
Dividend Yield
9.652199092693285% Rev. per Employee
N/AMore quote details and news »GUTinYour ValueYour ChangeShort position
(GUT) traded at a 70% premium to NAV just before it announced on Aug. 19, 2010, that it was reviewing its distribution policy. Investors rightly interpreted that to mean a reduction was coming. The shares tumbled to $5.58 by the end of that month, from $8.18, and the premium shriveled to 15%. The fund now trades at $8.03, a 42% premium. Gabelli Utility has returned 9.5% annually since inception in 1999, assuming dividends were reinvested.

To its credit, Gabelli Utility tells investors in its quarterly reports that "we believe that an excessive premium for the fund is not likely to be sustainable." David Schachter, the fund's ombudsman, elaborates: "The higher the premium, the higher the risk."

It behooves an investor to know if distributions come from interest or dividend income, or the sale of assets, which can go on only for so long before the payout is cut.

Closed-end premiums can remain lofty for extended periods. But, as Marilyn Cohen, CEO of Envision Capital Management, warns, bells don't go off at the top. By the time you want to get out, it may be too late.